Dr Pepper Snapple Poised at Neutral

We have maintained a Neutral rating on Dr Pepper Snapple Group Inc.(DPS) following appraisal of first quarter 2012 results.

Dr Pepper Snapple reported first quarter 2012 adjusted earnings (excluding mark to market gains) of 46 cents per share, down 8% from the year-ago earnings of 50 cents per share. Earnings plummeted as top-line growth was offset by a decline in margins. The company’s quarterly earnings also missed the Zacks Consensus Estimate of 48 cents per share.

During the quarter, Dr Pepper's net sales grew nominally 2% year over year to $1.36 billion as benefit from price/mix was offset by volume declines. Net sales were in line with the Zacks Consensus Estimate of $1.36 billion. Gross margins declined 210 basis points in the quarter primarily due to higher packaging and ingredient costs. The company reported consolidated adjusted operating income of $186 million in the first quarter, down 7% from the prior-year period as revenue growth and benefits from productivity improvement were offset by higher input and marketing costs.

Overall, we are encouraged by Dr Pepper’s strong position in the flavored carbonated soft drinks (CSD) market. Dr Pepper owns some of the most popular CSD and non carbonated beverages (NCB) brands. The company holds the #1 position in the flavored CSD market in the US with a market share of 40% in 2011. Dr Pepper soft drink, the most popular CSD brand, holds the #2 position in the flavored CSD market in the US. The company’s portfolio of well-established flagship brands offers a strong competitive advantage and strengthens its position in the market. The well-liked brand portfolio also leads to impressive margins and cash flows.

In 2010, Dr Pepper launched its Rapid Continuous Improvement (RCI) program under which the company is working to free up critical resources, people, time and money so that these can be used to build brand value. Therefore, the company has been able to reduce inventory and storage costs and improve cash flows which can in turn be returned to shareholders via dividends and share repurchases. Dr Pepper anticipates that the program will lead to a cash productivity of at least $150 million through 2013.

However, weak volumes, a difficult macroeconomic environment and rising input costs keep us on the sidelines. Further, changing consumer preferences toward healthier drinks, as a result of heightened awareness, are affecting the company’s CSD volumes. Moreover, the company mainly operates its business in the U.S., Canada and Mexico, which are experiencing saturation. It thus lacks exposure in the fast growing emerging markets where demand is growing and health consciousness is comparatively less. This is a significant competitive disadvantage for Dr Pepper versus its peers like The Coca Cola Company (KO) and PepsiCo, Inc. (PEP) which have significant exposure overseas.